EUR 850.00 For Business Accounts Only

Morningstar | HKCG Adds to New Energy Business but Remains Slightly Overvalued

Our view on Hong Kong and China Gas, or HKCG, is unchanged and the company’s strong free cash flow generation from its mature, Hong Kong gas business allows investment in the higher growth China gas business and also in new energy. The company provided two updates since the first-half result with a CNY 550 million investment in Foshan Water Environmental Protection, a water services project in the Greater Bay Area, and the completed construction of a gas storage facility in Jintan, Changzhou. The acquisition is minor in the overall context and our fair value of HKD 13.50 is unchanged. Compared with the Hong Kong electricity utilities under our coverage, HKCG is exposed to higher growth given its China exposure. Gas demand in China should remain resilient in the medium term and growth will come through from both increased gas demand and higher take-up of gas. This is driven by government policy to lower pollution and gas emission by focusing on replacing coal with gas. For the Hong Kong business, the company earns a higher return relative to its electricity peers as its return is unregulated. However, we believe the upside from the China business is priced into current share price. The utility is trading at a 12% premium to our fair value despite a pullback in its share price in recent months.

The gas storage facility was completed in two phases. Phase one was completed in January 2018, storing 140 million standard cubic metres. The completion of the second phase added another 300 million standard cubic metres and will alleviate pressure on gas supply during the winter months. This was the case last winter with a shortage in gas resulting in higher input cost for the company, resulting in lower operating margins. For the water joint venture with Foshan Water Environmental Protection, the latter provides 1.94 million tonnes of water every day from 15 water plants. The acquisition in the Greater Bay Area was not a surprise as management noted its preference for projects in the region over any in the Belt and Road projects. The latter’s demographic was unfavourable and it is unlikely piped gas is needed in the medium term. We continue to expect further acquisition for growth in China for HKCG and the company’s long operating history in China adds comfort to acquisition and execution risk.